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How Has MiFID II Affected U.S. Managers?

The start of 2018 marked the arrival of one of the most significant financial regulatory changes the European Union has seen in recent years. The original Markets in Financial Instruments Directive (“MiFID”), which came out in 2007 just prior to the financial crisis in 2008, was then reviewed in 2012 following criticism regarding transparency within the industry and the changes were finally put into action in the form of MiFID II on January 3, 2018.

The revised Directive looks to tighten regulation and provide greater transparency across the E.U. by:

Harmonizing the operating requirements among investment firms;

Fostering more effective investor activity across a broad and complex set of financial instruments and services; and

Addressing weaknesses in the functioning and transparency of financial markets.

Whilst there are several important changes that asset managers have had to make, one area that will have a significant impact on U.S. managers is the ‘unbundling rules,’ which prohibit the payment of research from being tied to the payment of execution fees, thereby giving investors greater clarity as to what they are being charged by brokers. Managers must now either pay for their research directly from their fund’s P&L, or, if they choose to use their clients’ funds, they must use a segregated research payment account (“RPA”).

As with most non-U.S. regulations, the impact of MiFID II largely depends on the level of contact or interaction the U.S. manager has with the E.U. Many U.S. asset managers are already subject to requirements in various E.U. jurisdictions under the E.U.’s Alternative Investment Fund Managers Directive (“AIFMD”) and therefore have a basic understanding of how these regulatory changes can impact their investment processes, but most are only just coming to terms with the full scale global effect. Where the original MiFID legislation affected only U.K. and E.U. firms, primarily on the sell side, the new rules will mean that anyone who has relationships with the E.U. as an investor, customer or counterparty, will now be affected.

Behind closed doors, Wall Street brokers have been lobbying to steer legislation away from conforming to the E.U.’s new rules. However, huge state pension funds have been putting up strong resistance, saying that the new rules will reduce costs and allow greater clarity across the market. As a result, the SEC has had to bring this debate out into the open. Having consulted with the European Commission and to allay the growing fears and confusion, the SEC eventually sided with the brokers on a temporary basis by introducing short-term, no-action relief towards the end of 2017. This relief came in the form of three no-action letters, confirming that the SEC would not prosecute any of the following situations:

A broker-dealer that sells research to an investment manager subject to MiFID II without complying with the Investment Advisers Act of 1940;

A money manager that relies on Section 28(e) of the Securities Exchange Act of 1934 to pay for brokerage and research services while complying with the side-by-side payment mechanism under the Directive;

An adviser complying with MiFID II that relies on previous no-action relief from Section 17 and Rule 17d-1 of the Investment Company Act of 1940 and Section 206 of the Advisers Act to aggregate orders for client accounts.

These no-action letters allow U.S. asset managers to make payments for research separately from trades, ensuring that U.S. managers can still receive access to valuable research from the E.U. However, this step towards a dual regulatory system will only be available until July 2020, when the no-action relief will cease and presumably the U.S. will adopt a similar framework to comply with the E.U. rules.

For those that are subject to the full MiFID II obligations, the cost of these changes is only just coming to light, with some consulting firms initially estimating a global spend of approximately $2 billion to incorporate the changes. However, at the close of Q1 2018, several managers reported lower relative costs than this. Moody’s reported that funds are looking between a 0.5-5% increase in costs, to cover all changes related to the legislation, with the smaller managers being the hardest hit. As time passes and more evidence is collected measuring the effects the new legislation has had and the quality of the research being provided, there will be an opportunity for the U.S. to determine how it will adhere to these rules in the future. U.S. asset managers hope the SEC can use the E.U. as an example and establish a fully robust yet practical approach to the demand for greater transparency. A recent survey conducted by RSRCHXchange looking at the global effect of MiFID II has seen a large number of U.S. asset managers agreeing that the U.S. could be only four years behind the E.U. in establishing the requirements for stricter regulation.

Overall, the U.S. has taken the flexible approach for the time being, allowing individual firms to take the decision whether they wish to continue their relationships with the E.U. However, there is no doubt that once the no-action relief expires, there will be a shift in the industry’s attitude toward research. It is likely the new rules will require a degree of transparency in costs that heretofore weren’t seen within the industry.

Robert Mirsky is the Head of EisnerAmper's London Office and Head of the firm's Asset Management Group. With years of experience in advising financial services companies, investors and asset managers in the operational aspects of funds and managers.